Goushi Kataoka

Member of the Policy Board

Economic Activity, Prices, and Monetary Policy in Japan

Speech at a Meeting with Business Leaders in Okayama

Bank of Japan

M a r c h 1 , 2 0 1 8

(English translation based on the Japanese original)

1

I. Developments in Economic Activity and Prices

A. Recent Developments and Outlook for Economic Activity at Home and Abroad

I would like to start my speech by looking at developments in the global economy affecting

Japan's economy. Since the autumn of 2017, improvement in economic sentiment has been

noticeable worldwide (Chart 1). The global Purchasing Managers' Index (PMI) has shown

remarkable improvement for manufacturing activity in particular, and business fixed

investment and trade volume have been increasing. One of the factors underlying this

improvement in economic sentiment is that, while advanced economies remain robust, there

is a cyclical factor of continued moderate recovery in production for the resource and

manufacturing sectors, which bottomed out in 2016 amid the waning of concern over a

slowdown in emerging economies, especially China. The cultivation of the potential

demand by utilizing new technologies -- such as the Internet of Things (IoT), artificial

intelligence (AI), and autonomous driving -- also contributes to the improvement to some

extent (Chart 2).

Looking at the global economy from the two perspectives of the real GDP growth rate and

the inflation rate, developments can be described as follows. Until 2016, the economy

remained in a phase where sluggish growth coexisted with low inflation. In 2017, it moved

into a phase where an improving trend in the growth rate became evident while the inflation

rate remained low. Looking ahead, the global economy is likely to shift to a phase where

inflation is clearly accelerated by continued relatively high growth if various downside risks

that have been pointed out, such as the following, do not materialize: (1) the risk of

monetary policy normalization in the United States and Europe exerting downward pressure

on the global economy; (2) the risk of deceleration in the Chinese economy; and (3)

geopolitical risks surrounding North Korea and the Middle East. One of the key points for

the time being is whether the global economy will reach the phase of rising inflation with

high growth that I just mentioned, while avoiding a situation of economies stalling, with

major economies beginning to see changes in their monetary policy stances, and if such a

phase is achieved, when that will happen.

Next, I would like to turn to developments in Japan's economy. Supported by the moderate

growth in the global economy, Japan's real GDP has continued to mark positive growth for

2

eight consecutive quarters since the first quarter of 2016. The annual real growth rate for

2017 stood at 1.6 percent, the highest level since 2013 (Chart 3). The breakdown by

component during this period shows that private business fixed investment and exports are

the major driving forces of the growth.

With regard to the outlook, in fiscal 2018, Japan's economy is likely to continue growing at

a pace in the range of 1.0-1.5 percent, exceeding its potential (Chart 4). This is because

business fixed investment will increase, reflecting improvements in corporate profits and

business sentiment, and exports will rise on the back of robust growth in the global

economy. These positive developments will then transmit more strongly than before to

households through a rise in wages, which will lead to some acceleration in the pace of

growth in private consumption. Meanwhile, it is highly likely that the economic growth rate

for fiscal 2019 will decrease to the range of 0.5-1.0 percent, reflecting such factors as (1)

the effects of the consumption tax hike scheduled in October 2019 and (2) deceleration in

business fixed investment due to the peaking out of Olympic Games-related demand.

Now, I would like to talk about the effects of the scheduled consumption tax hike. The hike

will have some impact on the GDP growth rates, mainly due to changes in household

spending, through the following two major channels: (1) the front-loaded increase and

subsequent decline in demand prior to and after the consumption tax hike and (2) the

decline in real income. At present, the negative impact of the hike on the projected growth

rate for fiscal 2019 is likely to be smaller than that on the rate for fiscal 2014, when the last

hike took place. This is because the increase in the consumption tax rate is smaller than that

of the most recent tax hike and a reduced tax rate will be applied to some items. In addition,

as the consumption tax hike is scheduled to take place in the middle of the fiscal year, there

are technical factors; namely, that the front-loaded increase and subsequent decline in

demand prior to and after the hike will offset each other during the fiscal year, and a decline

in real income could only occur in the second half of the fiscal year.

B. Recent Developments and Outlook for Japan's Prices

Next, I will move on to recent price developments in Japan and their outlook.

3

Looking at recent developments in the consumer price index (CPI), the year-on-year rate of

increase in the CPI for all items less fresh food for January 2018 was 0.9 percent. However,

it should be noted that the contribution of energy items was significant, at 0.5 percentage

point, and in terms of the rate of increase for all items less fresh food and energy, which

directly reflects domestic supply-demand conditions, the rate only stood at 0.4 percent

year-on-year. Although this rate indicates a continued moderate increase, its level is still low,

mainly against the background that firms' wage- and price-setting stance remains cautious

so far.

As for the outlook, I would like to first take a look at the Bank's baseline scenario.

According to the Outlook for Economic Activity and Prices (Outlook Report) released in

January 2018, inflation expectations are projected to rise as firms' stance gradually shifts

toward raising wages and prices with the economy still growing at a pace above its potential

and the output gap continuing to improve. It also indicates that, as a consequence, the

inflation rate is likely to continue on an uptrend and increase toward 2 percent. With this

mechanism operating, the inflation rate -- specifically, in terms of the median of the Policy

Board members' forecasts for the year-on-year rate of change in the CPI (all items less fresh

food) -- is projected to rise to around 1.8 percent through fiscal 2019, excluding the direct

effects of the consumption tax hike (Chart 4).

In contrast to this baseline scenario, I consider that the possibility of the year-on-year rate of

change in the CPI increasing to 2 percent through fiscal 2019 is low at this point. This

difference in the price outlook reflects the discrepancy in how to view the overall

effectiveness of the current monetary easing policy and the functioning of the policy's

transmission channels. I will elaborate on this later when I explain the conduct of monetary

policy.

II. Conduct of Monetary Policy

In what follows, I describe the Bank's monetary policy. I would like to first explain the

current framework and then present my views on policy measures necessary for achieving

the Bank's price stability target.

4

In January 2013, the Bank set the price stability target at 2 percent in terms of the

year-on-year rate of change in the CPI, and has been aiming at achieving this target at the

earliest possible time. The Bank also announced strengthening of policy coordination with

the government by releasing a joint statement, and the two entities have been working

together to overcome deflation early and achieve sustainable economic growth with price

stability. Under these circumstances, the Bank introduced Quantitative and Qualitative

Monetary Easing (QQE) in April 2013. Since September 2016, it has been conducting

monetary policy under the framework of QQE with Yield Curve Control. This current

framework for monetary policy consists of two major components (Chart 5).1

The first is yield curve control in which the Bank controls short-term and long-term

nominal interest rates and thereby encourages a decline in real interest rates -- calculated as

nominal interest rates minus expected inflation rates -- so as to achieve highly

accommodative financial conditions and stimulate economic activity and prices. The Bank

has set the short-term policy interest rate at minus 0.1 percent and the target level of 10-year

Japanese government bond (JGB) yields at around 0 percent. It conducts purchases of JGBs

so as to achieve these targets, thereby encouraging the formation of an optimal shape of the

yield curve to achieve the 2 percent price stability target.

The second component is an inflation-overshooting commitment. Under this commitment,

the Bank continues expanding the monetary base until the year-on-year rate of increase in

the observed CPI (all items less fresh food) exceeds 2 percent and stays above this target

level in a stable manner. With this commitment, the Bank aims to increase its credibility

among the public that it will achieve the 2 percent price stability target by ruling out the

possibility of a change in the direction of monetary policy at an early stage when

achievement of the target comes in sight.

In my view, this monetary policy framework will lead to higher inflation, mainly through

four transmission channels (Chart 6). The first is highly accommodative financial conditions

1 In addition to the two major components, the Bank conducts purchases of risky assets -- namely, exchange-traded funds (ETFs) and Japan real estate investment trusts (J-REITs) -- as part of monetary policy.

5

-- accompanying declines in real interest rates through declining nominal interest rates and

in risk premia -- to bring about an improvement in the output gap. The second is the

improvement in the output gap to push up the observed inflation rate. The third is the rise in

the observed inflation rate resulting in higher inflation expectations through the adaptive

expectation formation mechanism, which further raises the observed inflation rate. And the

fourth channel is that the Bank's strong commitment to achieving the 2 percent price

stability target will directly raise inflation expectations, prompting a rise in the observed

inflation rate in turn.

Earlier, when I described the outlook for prices, I mentioned that the possibility of the

year-on-year rate of change in the CPI increasing to 2 percent through fiscal 2019 is low.

This is because I still lack confidence that the four transmission channels I have just

explained are operating to an effective extent whereby the inflation rate will be pushed up to

reach 2 percent, even though more than a year has passed since the Bank's adoption of QQE

with Yield Curve Control. Of course, the positive effects of monetary easing are likely to

strengthen gradually, given that the improvement in the output gap continues. At this point,

however, my view is that the momentum for a rise in inflation is not strong enough to reach

2 percent through fiscal 2019.2

To illustrate this, I plot the relationship of the output gap and the inflation rate on a graph

(Chart 7). In the period after the adoption of QQE leading up to the introduction of QQE

with Yield Curve Control, the slope of the trend line became somewhat steep and the line's

level rose (Chart 7, red line in the left-hand panel) compared with that for an earlier period

(black line in the same panel). These developments suggest that ideal changes in the

economy had been taking place, implying that the effects through the second channel -- that

is, the improvement in the output gap that thereby pushes up the observed inflation rate --

2 For the inflation rate to increase to 2 percent going forward, I consider that it is essential to achieve a widening of the output gap that exceeds 2 percent, as well as a rise in the expected inflation rate that is greater than that observed during 2013 and 2014. This view is based on a projection of price developments derived by (1) estimating the so-called hybrid New Keynesian Phillips curve that takes the expected inflation rate, the observed inflation rate, the output gap, and the consumption tax dummy as explanatory variables and then (2) applying projections of the output gap -- deduced from the forecasts of the majority of the Bank's Policy Board members on real GDP growth -- and the expected inflation rate.

6

had been enhanced, and that both the third and the fourth channels had begun to operate

following a rise in inflation expectations. Taking a look at developments since the

October-December quarter of 2016, when the Bank introduced QQE with Yield Curve

Control, however, the slope of the trend line has become gradual and the line's level has

declined slightly, although these changes should be regarded as being subject to a margin of

error due to a limited sample size (Chart 7, green line in the left-hand panel). This suggests

the possibility that, although the first channel has been operating, the other three channels

have not yet been doing so to their full extent.3

In other words, under the current monetary policy framework, supply-demand conditions

are tightening further, but this has not yet affected firms' overall price-setting stance toward

raising prices.4 It also should be noted that the rise in inflation expectations remains

moderate, partly reflecting the moderate pace of increase in the observed inflation rate.

Short-term inflation expectations have increased somewhat, due mainly to the rise in crude

oil prices, but they have not recovered to the level seen in the period between mid-2014 and

mid-2015, when such expectations shifted from increasing to being flat. Medium- to

long-term inflation expectations remain somewhat weak (Chart 8). I would note that the

inflation-overshooting commitment was effective in stopping a decline in inflation

expectations, but it has not been sufficient to clearly increase inflation expectations.

On the basis of such understanding, I believe that further monetary easing is necessary to

achieve the price stability target at an early stage. Specifically, the Bank should purchase

JGBs so that yields on JGBs with maturities of 10 years and longer will broadly be lowered

further. With a view to reinforcing the inflation-overshooting commitment, the Bank should

also add the commitment that, in terms of the medians of the Policy Board members'

3 These facts also can be confirmed from an estimate of the Phillips curve with time-varying parameters (Chart 7, the right-hand panel). 4 The output gap estimated by the Bank's Research and Statistics Department became positive from the October-December quarter of 2016 and has increased further to 1.35 percent in the July-September quarter of 2017. Having said that, a further widening of the output gap is necessary to affect firms' overall price-setting stance toward raising prices, in view of the fact that the average of the output gap was in the range of 2.5-3.0 percent in the past when the year-on-year rate of increase in the CPI (all items less fresh food and energy) exceeded 2 percent on a basis excluding the effects of consumption tax hikes.

7

forecasts presented in the Outlook Report, if there is a delay in the timing of achieving the

price stability target due to domestic factors, the Bank should take additional easing

measures.

I would note that a further lowering of yields on JGBs with maturities of 10 years and

longer will promote business fixed investment and housing investment to a greater extent

from the financial side. This lowering of JGB yields is also expected to have synergy effects

with the government's fiscal policy providing tax support for firms that have a positive

stance toward making fixed investment and raising wages. These developments will further

increase the pace of improvement in the output gap, and thus enhance the dynamism of the

rise in the inflation rate through the first and second transmission channels that I explained

earlier. Among many options for additional monetary easing measures under yield curve

control, the further lowering of yields on JGBs with maturities of 10 years and longer is the

best at this point, in my view, considering the balance between positive and negative effects.

Strengthening of the inflation-overshooting commitment aims at increasing the transmission

effects of higher inflation expectations on the observed inflation rate -- in other words,

increasing the effects through the third and fourth transmission channels. The rise in

inflation expectations from 2013 was attributable to the Bank's decision to introduce an

inflation targeting policy. It also was attributable to the initiatives taken to achieve the

policy; the Bank announced the strengthening of policy coordination with the government

by releasing the joint statement, and the two entities have taken concrete actions by

implementing flexible fiscal policy and bold monetary policy as well as the growth strategy.

In order to influence inflation expectations, it is essential that policy coordination with the

government aiming at achieving the price stability target be firmly ensured through both

entities' concrete actions. The Bank, for its part, should further promote powerful monetary

easing backed by a clear and strong commitment to achieving the price stability target.

III. Reason for Importance of Achieving and Maintaining the Price Stability Target

As the global economy continues to grow at a moderate pace, the Federal Reserve is on

course to raise policy interest rates and the European Central Bank is moving toward an exit

from monetary easing. Under such circumstances, there is some speculation, especially

8

overseas, that Japan's monetary policy might also shift to a tightening in the near future, or

might at least make a slight adjustment toward an exit from monetary easing. However, the

inflation environment in Japan differs substantially from that in the United States and major

countries in Europe. I believe that, in Japan, there is still a long way to go before

considering a change in monetary policy stance.

Let me first look at price developments in Japan as well as in the United States, where the

policy rate hike is proceeding. Chart 9 compares developments in the inflation rate

excluding those of fresh food and energy between Japan and the United States since 1995.

The bold black line indicates an inflation rate of 2 percent and the gray bands show

recession periods. In the United States, the inflation rate has been more or less at around 2

percent from 1995 to the present. On the other hand, in contrast to the United States, the

inflation rate in Japan moved in negative territory for most of the time during the period

between the latter half of 1998 and early 2013. In 2013 onward, the inflation rate has turned

positive, mainly due to the introduction of QQE, but remains distant from 2 percent.

Such a difference in price developments between Japan and the United States is often

compared to the existence or absence of an anchor that stabilizes a ship in the ocean. The

inflation rate generally fluctuates with volatilities of and shocks to the macroeconomics and

market conditions, such as crude oil price changes. In the United States, however, the

inflation rate has returned to close to 2 percent even after major shocks such as the global

financial crisis following the failure of Lehman Brothers. This is because people's inflation

expectations are firmly fixed, just as a ship is anchored, at around 2 percent.5 In my view,

the reason why incremental policy rate hikes have been possible in the United States so far

is that inflation expectations are judged to be anchored well. In Japan, on the other hand,

firms' and households' mindset has been formed under the prolonged deflationary

environment after the mid-1990s, such that economic activity assuming no inflation has

5 For the implications of inflation expectations being anchored, see Ben Bernanke, "Inflation Expectations and Inflation Forecasting: Speech at the Monetary Economics Workshop of the National Bureau of Economic Research Summer Institute, Cambridge, Massachusetts," Federal Reserve Board (July 2007).

9

become rational. In other words, Japan has lost the anchor for inflation expectations and has

been stuck in a deflationary equilibrium.6

The Bank, through its bold monetary easing policy, now aims at shifting the economy from

being stuck in a deflationary equilibrium to entering an inflationary equilibrium in which

inflation expectations are anchored at around 2 percent. However, as I have explained so far,

the improvement in the inflation rate is not enough and still only halfway accomplished. If

the direction of monetary policy is changed without deep consideration in such a situation,

there is a risk of the economy fully returning to a deflationary equilibrium.

After the introduction of QQE in April 2013, inflation expectations rose steadily toward 2

percent. However, the momentum weakened, stemming from the consumption tax hike and

the fall in crude oil prices. Subsequently, a headwind -- that is, a slowdown in emerging

economies and instability in global financial markets -- led to sluggishness in inflation

expectations. This experience suggests that, at the stage where the 2 percent price stability

target is not yet achieved, inflation expectations are susceptible to negative economic

shocks and the economy could easily return to a deflationary equilibrium.7

That is the very reason why it is necessary to carefully conduct the current monetary policy

by giving full consideration to risks to economic activity and prices.8 Going back to my

6 See James Bullard, "Seven Faces of 'The Peril'," Federal Reserve Bank of St. Louis Review, vol. 92, no. 5 (2010): 339-52. Based on Japanese and U.S. data for 2002-2010, Bullard discusses the possibility of the U.S. economy at that time falling into a deflationary equilibrium like Japan, and analyzes monetary policy so as to avoid such equilibrium. 7 See Ryan Banerjee and Aaron Mehrotra, "Deflation Expectations," BIS Working Papers, no. 699 (February 2018). The authors found that, by analyzing inflation expectations across 43 economies, expectations become "less well anchored" and are associated with "somewhat higher backward-lookingness" during deflations. 8 In assessing the effects of large-scale monetary policy on the financial system and the functioning of financial intermediation, multiple factors also should be taken into account; for example, (1) effects of developments in lending rates, (2) declines in firms' bankruptcy rates and in banks' credit costs, both resulting from monetary easing, and (3) effects of improvement in asset markets pushing up financial institutions' profits. When making monetary policy decisions, it is necessary to give due consideration to the likelihood that the longer it takes to achieve the price stability target, the more risks to the robustness of the financial system arise.

10

earlier reference to recent developments and the outlook for economic activity and prices,

from the perspective of careful conduct of monetary policy, I believe that the following two

points require due attention, particularly with regard to the assessment of economic

developments in fiscal 2019.

The first point to be considered is that, since the most recent consumption tax hike in fiscal

2014, a rise in real disposable income has not strongly linked to an increase in real

consumption. It should be noted that, if the next consumption tax hike scheduled in October

2019 causes similar effects, improvement in aggregate demand will not make sufficient

progress. I also would note the possibility that, if the tax hike takes place when the anchor

of inflation expectations is not yet functioning effectively, people's inflation perceptions

might change and, mainly due to declines in consumption, inflation expectations might

become sluggish again.9 That is, there is a possibility that the tax hike could increase

downward pressure on prices through both channels of the output gap and inflation

expectations (Chart 10).

The second point is that there is some possibility that risks to developments in overseas

economies will materialize by fiscal 2019. If the risks materialize, Japan's economy will

slow down to some degree as it loses support from the firm growth in the global economy.

In my view, particular attention should be paid to the risk that U.S. monetary policy

normalization will put downward pressure on the global economy, as its potential impact on

the global economy is larger than that of other risks.

9 As for the impact of the tax hike on the inflation rate and inflation expectations, one possibility is a decline in aggregate demand to push down the observed inflation rate, which will lower inflation expectations in turn. Another possibility is a rise in prices accompanied by the tax hike to raise inflation expectations. Earlier episodes of tax hikes in April 1997 and April 2014 suggested that the inflation rate initially rose following each hike but declined as aggregate demand decreased, thereby causing a fall in inflation expectations.

11

Following the bursting of the bubble in the 1990s, Japan experienced a prolonged period of

economic stagnation aggravated by deflation, described as the "lost two decades."10 Since

2013, the price situation is finally no longer deflationary, owing to the improvement in the

environment surrounding firms and households -- such as represented by the employment

situation -- in addition to the Bank's implementation of bold monetary easing policy.11

While Japan's economy is still on its way toward achieving and maintaining the price

stability target, as I described earlier, it is necessary to augment the momentum of the

virtuous cycle that has emerged during the process toward achieving this target, and put an

end to the "lost two decades" for good by realizing the target at an early stage. As a member

of the Policy Board of the Bank, I will continue to devote the best of my abilities toward

achieving and maintaining the price stability target.

Thank you for your attention.

10 For details about Japan's prolonged stagnation, see the following publications: (1) Koichi Hamada, Anil Kashyap, and David Weinstein, Japan's Bubble, Deflation, and Long-term Stagnation (Massachusetts: The MIT Press, 2010); (2) Masazumi Wakatabe, Japan's Great Stagnation and

Abenomics: Lessons for the World (New York: Palgrave Macmillan, 2015); and (3) Kataoka Goushi, Nihon no "Ushinawareta 20-nen": Defure o koeru keizai seisaku ni mukete [Japan's Lost Two Decades: For economic policies to overcome deflation] (Tokyo: Fujiwara-Shoten, 2010). 11 See Adachi Seiji, "2 pāsento no infure mokuhyō wa datō ka" [Is an inflation target of 2 percent appropriate?], Keiki to Saikuru (Japan Association of Business Cycle studies), no. 64, November 2017. Adachi estimates a New Keynesian Phillips curve by adopting the framework of the Logistic Smooth Transition Autoregressive model, on the assumption of two regimes; namely, a "deflationary regime" and an "inflationary regime." Looking at the estimates on the probability of a regime change, the figure for the April-June quarter of 2017 is estimated at 57.8 percent. While this is greater than 50 percent -- the threshold between the "deflationary regime" and the "inflationary regime" -- it suggests that the economy is still distant from 100 percent, a level that would indicate the economy's complete overcoming of deflation.

Economic Activity, Prices,

and Monetary Policy in Japan

March 1, 2018

Goushi Kataoka

Member of the Policy Board of the Bank of Japan

Speech at a Meeting with Business Leaders in Okayama

Chart 1 Global Economy (1)

Global PMI

Note: Figures are from the J.P. Morgan Global PMI. Figures above 50

indicate improvement and below 50 show deterioration on a

month-on-month basis.

Source: IHS Markit (© and database right IHS Markit Ltd 2018. All

rights reserved.). 1

Projections of Real GDP Growth by

Major Economies (as of January 2018)

Note: Figures in the column “Revision” indicate differences from the

projections as of January 2017.

Source: IMF, “World Economic Outlook Update, January 2018.”

Projection

for CY 2018 Revision

World 3.9 +0.3

Advanced economies 2.3 +0.3

United States 2.7 +0.2

Euro area 2.2 +0.6

Emerging market and

developing economies 4.9 +0.1

China 6.6 +0.6

y/y % chg., % pts.

45

50

55

60

13 14 15 16 17 18

Global Manufacturing PMI Output Index

Global Services PMI Business Activity Index

DI, % pts.

CY

Chart 2 Global Economy (2)

Note: “Communications” includes smartphones, “Computer, etc.” includes PCs and data centers, “Consumer”

mainly represents household electrical appliances, and “Industry, etc.” includes industrial robots.

Source: Semiconductor Industry Association, 2017 and 2014 Factbook. 2

Global Semiconductor Demand by End Use

Communica-

tions

Computer,

etc.

Consumer

Industry, etc.

Automotive

0

50

100

150

200

250

300

350

CY 13 CY 16

bil. USD

Chart 3 Japan’s Economy (1)

Real GDP Growth and Breakdown by Component

Source: Cabinet Office, “Quarterly Estimates of GDP for October-December 2017 (First Preliminary Estimates).” 3

-15

-10

-5

0

5

10

15

20

CY 13 14 15 16 17

Private consumption Private business fixed investment, etc.

Government spending Exports

Imports Change in inventories, etc.

Real GDP

ann., q/q % chg.

CY 13 14 15 16 17

Chart 4 Japan’s Economy (2)

Medians of the Policy Board Members’ Forecasts (as of January 2018)

Notes: 1. Figures indicate the forecasts (point estimates) presented in the January 2018 Outlook Report.

2. The consumption tax hike scheduled to take place in October 2019 (to 10 percent) and the reduced tax rate to be applied

to food and beverages (excluding alcohol and dining-out) and newspapers are incorporated in the forecasts.

Source: Bank of Japan. 4

Real GDP

CPI

(all items less

fresh food)

Excluding the

effects of the

consumption

tax hike

FY 2017 +1.9 +0.8

Forecasts made in

October 2017 +1.9 +0.8

FY 2018 +1.4 +1.4

Forecasts made in

October 2017 +1.4 +1.4

FY 2019 +0.7 +2.3 +1.8

Forecasts made in

October 2017 +0.7 +2.3 +1.8

y/y % chg.

Chart 5 QQE with Yield Curve Control

5

Yield Curve Control Inflation-Overshooting Commitment

40 Residual maturity

(year)

JGB yield (%)

10 20 30 0

0

Short-term policy interest rate:

minus 0.1 percent

Target level of 10-year

JGB yields:

around 0 percent 2 %

Inflation rate (%)

Continuation of monetary base expansion

Time

Chart 6 Transmission Channels of

Monetary Easing to Prices

Decline in Nominal Interest

Rates and Risk Premiums

Adaptive formation of

inflation expectations

6

Improvement in Output Gap

Reinforcement of

Commitment

Rise in Inflation Expectations

Increase in Inflation Rate

Achievement and Maintenance of

the Price Stability Target

Facilitating private investment

Stabilizing financial markets

Improving credibility in

inflation targeting policy

Greater increases in base wages

Facilitating cost pass-through

Realization of inflation expectations

Increasing upward pressure on wages

Raising capital utilization rates

Improving labor market conditions

1

2 3

4

Declining real interest rates through

declining nominal interest rates

Increasing effectiveness of monetary easing

Exerting synergy effects with fiscal policy

Chart 7 Output Gap and Inflation Rate

Notes: 1. Trend lines are determined as <Inflation Rate> = Intercept + Slope *

<Output Gap [-3]>.

2. Inflation rate (vertical axis) shows year-on-year growth in the CPI (all

items less fresh food and energy).

3. Output gap (horizontal axis) is lagged behind the inflation rate by 3

quarters. Figures are estimated by the Research and Statistics

Department of the Bank of Japan (lag is determined by timing

correlation).

Sources: Ministry of Internal Affairs and Communications; Bank of Japan. 7

Output Gap and Inflation Rate Reference: Intercept and Slope of

the Phillips Curve

Notes: 1. Figures are estimation results of the Phillips curve obtained by

employing time-varying intercepts and slopes in the left-hand

panel. Estimation period is from January 1983 through December

2017.

2. Output gap is lagged by 3 quarters (lag is determined by the AIC).

Sources: Ministry of Internal Affairs and Communications; Bank of Japan.

-2

-1

0

1

2

3

-8 -6 -4 -2 0 2 4

Infl

ati

on

Rate

%

%Output Gap (3-quarter lagged)

Oct. 1999-Mar. 2013

Before QQE with Yield Curve Control

Apr. 2013-Sept. 2016

After QQE with

Yield Curve Control

Oct. 2016-Dec. 2017

0.00

0.05

0.10

0.15

0.20

0.25

-0.8

-0.4

0.0

0.4

0.8

1.2

10 11 12 13 14 15 16 17

Intercept

Slope (right axis)

CY

%

Introduction of QQE

(April 2013)

Introduction of

Yield Curve Control

(September 2016)

Chart 8 Inflation Expectations

Notes: 1. Lines in the left-hand panel show the average outlook for general prices for all industries and enterprises released in the Tankan.

2. Inflation expectations of firms, households, and experts are synthesized in the right-hand panel. Inflation expectations of firms are represented by

the Tankan and those of households are represented by the Bank’s Opinion Survey on the General Public‘s Views and Behavior. For experts’ inflation

expectations, data from the Consensus Forecasts, the QUICK Survey, and the inflation swap rate are used, which is shown as the different lines

respectively.

3. Semiannual data from the Consensus Forecasts up through 2014/Q2 are linearly interpolated. Figures for the Opinion Survey exclude inflation

expectations by respondents whose annual inflation expectations were ±5% or greater. The output prices DI in the Tankan represents the difference

between the share of firms that raised prices in the preceding three months and the share of firms that lowered prices.

Sources: Consensus Economics Inc., “Consensus Forecasts”; QUICK, "QUICK Monthly Market Survey (Bonds)"; Bloomberg; Bank of Japan. 8

Synthetic Indicators of Inflation Expectations Obtained through Principal Component

Analysis (Medium- to Long-Term) Firms’ Inflation Expectations (Tankan)

0.0

0.5

1.0

1.5

2.0

14 15 16 17

1-year horizon 3-year horizon

5-year horizon

y/y % chg.

CY

0.0

0.5

1.0

1.5

2.0

10 11 12 13 14 15 16 17

Consensus Forecasts

QUICK Survey

Inflation swap rate

CY

y/y % chg.

Chart 9 Comparison of Inflation Rates

in the United States and Japan

Notes: 1. Red dots show year-on-year changes in the PCE deflator (all items less fresh food and energy) for the United States, and those in the CPI

(all items less fresh food, energy, and excluding direct effects of consumption tax hikes) for Japan.

2. Bold black lines indicate inflation rate of 2 percentage points.

3. Black broken lines indicate average inflation rate after CY 95 (discontinued at the introduction of QQE for Japan).

4. Gray bands indicate recession periods (peaks and bottoms of business cycle are those determined by the National Bureau of Economic

Research for the United States and Cabinet Office for Japan).

Sources: Cabinet Office; Ministry of Internal Affairs and Communications; Federal Reserve Bank of St. Louis; National Bureau of Economic Research.

9

United States Japan

-2

-1

0

1

2

3

95 00 05 10 15CY

%

-2

-1

0

1

2

3

95 00 05 10 15

%

CY

Chart 10 Consumption before and after

Consumption Tax Hike Real Disposable Income and

Real Consumption Expenditures

Note: Data are for workers’ households with two or more members.

Source: Ministry of Internal Affairs and Communications,

”Family Income and Expenditure Survey.“

10

Average Consumption Propensity

Notes: 1. Average Consumption Propensity = Household Consumption

Expenditure / Household Disposable Income.

2. Disposable income for National Accounts includes that of private

unincorporated enterprises.

3. Figures for the Family Income and Expenditure Survey are those

for the average of each fiscal year (average of April to December

for 2017).

Sources: Cabinet Office, “System of National Accounts”; Ministry of Internal

Affairs and Communications, ”Family Income and Expenditure

Survey.“

90

95

100

105

110

115

120

90 95 100 105 110 115 120

CY 2015=100

Before most recent

consumption tax hike

(Jan. 2000-Mar. 2014)

After most recent consumption tax hike

(Apr. 2014-Dec. 2017)

Real Disposable Income

Real C

on

sum

pti

on

Exp

en

dit

ure

CY 2015=100

98

100

102

104

106

108

110

112

FY 2000 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17

System of National Accounts

Family Income and Expenditure Survey

Consumption tax hikeFY 2000=100